Deck 18: Forward Exchange and International Financial Investment

Question 1

In a _____ contract you can effectively lock in the price at which you buy or sell a foreign currency at a set date in the future.

A)securities spot
B)covered arbitrage
C)currency futures
D)spot foreign exchange

Answer 1

C

Question 2

The act of taking a net asset position or a net liability position in some asset class is referred to as _____.

A)hedging
B)speculating
C)investing
D)buying

Answer 2

B

Question 3

For an investor who starts with dollars and wants to end up with dollars in the future, which of the following choices is an example that includes hedging?

A)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency
B)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars
C)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate
D)Buy a dollar-denominated financial asset

Answer 3

B

Question 4

Which of the following is true for forward foreign exchange contracts?

A)Common dates for future exchange are 50, 100, and 150 days forward.
B)The actual currency exchange occurs after one week from the stated time period.
C)They are used mostly to offset net asset positions held in the foreign currencies.
D)They can be used for both speculation and hedging.

Question 5

Company X is a perfume manufacturer and one of its popular products involves rosewood. It is deeply concerned with the market price fluctuations of rosewood. To protect this, it enters into a contract which would allow the company to buy rosewood at a specific price at a given future date. This is an example of:

A)hedging.
B)speculation.
C)investment.
D)profit maximization.

Question 6

For an investor who starts with dollars and wants to end up with dollars in the future, which of the following choices is an example of a covered international investment?

A)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency
B)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars
C)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate
D)Buy a dollar-denominated financial asset

Question 7

Assume you are an American importer who must pay 500,000 Euros at the end of 90 days when you receive 1,000 cases of French wine at your warehouse in New York. Suppose that you have not covered this transaction in the forward market. In which of the following cases will you suffer the largest loss?

A)The euro spot exchange rate value vis-à-vis the dollar does not change
B)The euro (spot) initially appreciates by 2 percent, and then depreciates by 1 percent
C)The euro (spot) initially depreciates by 3 percent, and then appreciates by 2 percent
D)The euro (spot) initially appreciates by 3 percent, and then depreciates by 2.9 percent

Question 8

Concerning the covering of exchange rate risks, assuming that a depreciation of the domestic currency is feared, one can say that there is an incentive for:

A)exporters to rush to cover their future needs.
B)importers to rush to cover their future needs.
C)both exporters and importers to rush to cover their future needs.
D)monetary authorities to rush to cover their future needs.

Question 9

If an investor starts with dollars and wants to end up with dollars in the future, which of the following is NOT an investment choice that can be made?

A)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency
B)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars
C)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate
D)Buy a dollar-denominated financial asset

Question 10

An investment is _____ if it is fully hedged against exchange-rate risk.

A)covered
B)uncovered
C)speculative
D)risk neutral

Question 11

An import-export business that finds itself in a "short" foreign-currency position risks a financial loss if:

A)it pays attention to exchange rate forecasts.
B)foreign demand for its product rises (more than expected).
C)the domestic currency depreciates (more than expected)..
D)the foreign currency depreciates (more than expected)..

Question 12

If Canadian speculators expect the euro to appreciate against the U.S. dollar, they would:

A)purchase Canadian dollars.
B)purchase U.S.dollars.
C)purchase euros.
D)use Canadian dollars to buy euros, instantly use the euros to buy U.S.dollars, and then instantly use the U.S.dollars to buy Canadian dollars.

Question 13

Assume you are a Chinese exporter and expect to receive $250,000 at the end of 60 days. You can remove the risk of loss due to a devaluation of the dollar by:

A)selling dollars in the 60-day forward exchange market.
B)buying dollars now and selling these dollars at the end of 60 days.
C)selling the yuan equivalent in the forward exchange market for 60-day delivery.
D)keeping the dollars in the United States after they are delivered to you.

Question 14

Which of the following financial instruments provides a buyer the right (but not the obligation) to purchase or sell a fixed amount of currency at a prearranged price, within a few days to a few years?

A)Letter of credit
B)Currency option
C)Currency swap
D)Forward contract

Question 15

_____ means committing oneself to an uncertain future value of one's net worth in terms of home currency.

A)Selling
B)Hedging
C)Speculating
D)Importing

Question 16

For an investor who starts with dollars and wants to end up with dollars in the future, which of the following choices is an example of an uncovered international investment?

A)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency
B)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars
C)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate
D)Buy a dollar-denominated financial asset

Question 17

Assume you are an American importer who must pay 500,000 euros at the end of 90 days when you receive 1,000 cases of French wine at your warehouse in New York. If you do not hedge this transaction, you face exchange-rate risk. The best way to remove the risk of loss due to currency fluctuations is to:

A)buy 500,000 euros in the forward exchange market for delivery in 60 days.
B)buy 500,000 euros now, hold them for 60 days, and then sell them at the spot exchange rate that exists 60 days from now.
C)sell 500,000 euros in the forward exchange market for delivery after 60 days.
D)sell 500,000 euros now in the spot market.

Question 18

If the spot price of the euro is $1.10 per euro and the 30-day forward rate is $1.00 per euro, and you believe that the spot rate in 30 days will be $1.05 per euro, then you can try to maximize speculative gains by:

A)buying euros in the current spot market and selling euros in 30 days at the future spot rate.
B)signing a forward foreign exchange contract to sell euros in 30 days.
C)signing a forward foreign exchange contract to sell dollars in 30 days.
D)buying dollars in the spot market and selling the dollars in 30 days at the future spot rate.

Question 19

A _____ gives the holder the right but not the obligation to sell a foreign currency at some time in the future at a price set today.

A)forward exchange contract
B)currency Swap
C)put option
D)call option

Question 20

An investment exposed to exchange-rate risk is a(n) _____ international investment.

A)covered
B)uncovered
C)hedged
D)arbitrage

Question 21

_____ is buying a country's currency spot and selling that country's currency forward, to make a net profit from the combination of the difference in interest rates between countries and the forward premium on the country's currency.

A)Covered interest arbitrage
B)Uncovered interest arbitrage
C)Covered interest parity
D)Uncovered interest parity

Question 22

Suppose the interest rate on one-year U.S. T-bills is 4% and interest rate on one-year British T-bills is 6.5%. If the dollar is at a one-year forward premium against the British pound of 3%, the covered interest differential is:

A)the same as the uncovered interest differential.
B)equally favoring investments in both the nations.
C)in favor of investments in the United Kingdom.
D)in favor of investments in the United States.

Question 23

For an investor who starts with dollars and wants to end up with dollars in the future, which of the following choices is an example that includes speculating?

A)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to sell the foreign currency
B)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy dollars
C)Sell dollars at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy dollars at the future spot rate
D)Buy a dollar-denominated financial asset

Question 24

Suppose the interest rate on one-year U.S. T-bills is 4% and interest rate on one-year British T-bills is 6.5%. If the dollar is at a forward premium against the British pound of 1%, an American investor who does not want to face exchange-rate risk (but does want to earn the highest possible return) should:

A)invest in dollar-denominated assets.
B)invest in pound-denominated assets.
C)forego use of the forward exchange rate market.
D)do nothing because exchange-rate risk is unacceptable.

Question 25

Consider the interaction between U.S. dollars and U.K. pounds. When the forward premium on the dollar is zero, it means:

A)the current spot price of dollars equals the future spot price of dollars.
B)the future spot price of dollars will be equal to the current forward price of dollars.
C)the current forward price of dollars equals the current spot price of dollars.
D)the spot exchange rate value of the pound is moving toward $1 per pound.

Question 26

When the current $/£ forward rate is below the current spot rate, the pound is at a(n) _____.

A)forward premium
B)forward discount
C)covered parity
D)uncovered parity

Question 27

The proportionate difference between the current forward exchange rate value of a currency and its current spot value is the _____ premium.

A)investment
B)frequent exchanger
C)forward
D)currency-option

Question 28

The covered interest differential is _____ the sum of the forward premium on a currency and the interest rate differential.

A)approximately equal to
B)more than
C)exactly equal to
D)less than

Question 29

If the covered interest differential is zero, then:

A)covered international investments will be profitable once we add in the interest earned on the foreign bonds.
B)covered interest rate parity has not yet been reached.
C)the overall covered return on a foreign-currency investment equals the return on a comparable domestic-currency investment.
D)a currency is at a forward premium by as much as its interest rate is higher than the interest rate in the other country.

Question 30

Using actual market exchange rates and comparable short-term interest rates for the major currencies:

A)uncovered interest parity is easier to test than covered interest parity.
B)we see that covered interest parity holds better between the currencies of countries that impose broad capital controls.
C)we see that deviations from uncovered interest parity occur only during times of crisis.
D)we see that covered interest parity usually holds well.

Question 31

Suppose the interest rate on 6-month treasury bills is 7 percent per year in the United Kingdom and 4 percent per year in the United States. Also, today's spot exchange price of the pound is $2.00 while the 6-month forward exchange price of the pound is $1.98. By investing in U.K. treasury bills rather than U.S. treasury bills, and covering exchange-rate risk, U.S. investors earn an approximate extra return for 6 months of:

A)0.5 percent.
B)1.5 percent.
C)3.0 percent.
D)4.0 percent.

Question 32

The interest rate is 4% in the U.K. and 3% in the U.S. for 90 days. The current spot rate is $2.00/£ and the forward rate is $1.96/£. If a U.S. based investor expects the spot rate to remain at $2.00/£ in 90 days, the expected uncovered interest rate differential would have to be _____ in favor of the _____ investment.

A)2%; dollar
B)2%; pound
C)1%; dollar
D)1%; pound

Question 33

Consider covered investments between the United States and Japan. If Japanese interest rates decrease, interest arbitrage operations will most likely result in a(n):

A)increase in the spot exchange price of the yen.
B)increase in the forward exchange price of the dollar.
C)sale of dollars in the forward market.
D)purchase of yen in the spot market.

Question 34

When uncovered interest parity holds, it means that:

A)a currency is expected to appreciate by as much as its interest rate is lower than the interest rate in the other country.
B)a currency is expected to appreciate by as much as its interest rate is higher than the interest rate in the other country
C)exchange rate risk is unusually high
D)the forward premium equals the interest rate differential.

Question 35

If the forward premium of the euro is positive, the exchange market's consensus appears to be that over the period of a forward contract, the spot exchange rate value of the euro will:

A)decrease.
B)increase.
C)remain constant.
D)fluctuate randomly.

Question 36

_____ parity is the condition where the expected uncovered differential equals zero.

A)Covered interest
B)Uncovered interest
C)Covered arbitrage
D)Uncovered arbitrage

Question 37

Suppose the interest rate on 6-month treasury bills is 7 percent per year in the United Kingdom and 4 percent per year in the United States. Also, today's spot exchange price of the pound is $2.00 while the 6-month forward exchange price of the pound is $1.98. If the price of the 6-month forward pound were to _____, U.S. investors would see no return difference between covered U.K. investment and domestic U.S. investment.

A)rise to $1.99
B)rise to $2.01
C)fall to $1.96
D)fall to $1.97

Question 38

If the expected uncovered interest differential is _____, then the expected overall return favors uncovered investing in the foreign-denominated currency.

A)positive
B)negative
C)zero
D)unchanged

Question 39

Suppose the interest rate in the U.K. is 4% for 90 days, the current spot rate is $2.00/£, and the 90-day forward rate is $1.96/£. If the covered interest rate differential is about zero, then the interest rate in the U.S. for 90 days is:

A)6 percent.
B)4 percent.
C)3 percent.
D)2 percent.

Question 40

Suppose the interest rate on 6-month treasury bills is 7 percent per year in the United Kingdom and 4 percent per year in the United States. Also, today's spot exchange price of the pound is $2.00 while the 6-month forward exchange price of the pound is $1.98. Consider the expected future spot rate of pounds is $2.04. By investing in U.K. treasury bills rather than U.S. treasury bills, and NOT covering exchange-rate risk, the approximate extra return earned by U.S. investors for 6 months will be:

A)0.5 percent.
B)5.0 percent.
C)3.0 percent.
D)3.6 percent.

Question 41

What is the empirical evidence on the holding of the covered and uncovered interest rate parity? How is the evidence different after the relaxation of capital controls in the early 1980s?

Question 42

Speculating in a position exposed to exchange-rate risk is the act of reducing or eliminating a net asset or net liability position in the foreign currency.

Question 43

Hedging a position exposed to exchange-rate risk is the act of reducing or eliminating a net asset or net liability position in the foreign currency.

Question 44

The profits and losses on a futures contract accrue to you daily, as the contract is "marked to market" daily.

Question 45

If the interest rate of a foreign country is less than that of the domestic country, then the foreign country will have a positive forward premium on its currency.

Question 46

Assume that the three-month forward exchange rate is $2.00/£ and a speculator believes that the spot rate in three months will be $2.05/£. How can this person speculate in the forward market? Also assume that the speculator is willing to take a position of about $20 million or £10 million. How much will the speculator earn if he or she is correct?

Question 47

The current spot exchange rate is $1.14/euro. The current 90-day forward exchange rate is $1.11/euro. How could a U.S firm, who must repay a 40 million euro loan in 90 days, use a forward exchange contract to hedge its risk exposure?

Question 48

Covered interest parity is rarely found to hold empirically.

Question 49

If Canada has a current 90 day forward exchange rate value for its currency that is above the current spot exchange rate value of its currency, then the Canadian 90-day interest rate is relatively high.

Question 50

If a currency is at a forward premium by as much as its interest rate is lower than the interest rate in the other country, covered interest parity holds.

Question 51

An unhedged international investment has a speculative element to it, and it is called a covered international investment.

Question 52

A bank deposit in Germany denominated in euros is a Eurocurrency deposit.

Question 53

Uncovered interest arbitrage is buying a country's currency spot and selling that country's currency forward, to make a net profit from the combination of the difference in interest rates between countries and the forward premium on the country's currency.

Question 54

Consider the case of a U.S. investor holding dollars and deciding whether to invest in Japanese treasury bills or in U.S. treasury bills. Assume that the investor wants to end up holding dollars. What are the three methods available to this investor to turn present dollars into future dollars? In your answer present an equation that shows the return per dollar invested under each method. Which of these methods is the riskiest and why?

Question 55

Suppose that the dollar-yen spot exchange rate is $0.05/¥ and the 90-day forward exchange rate is $0.06/¥. Assuming that covered interest parity holds, are Japanese interest rates higher or lower than U.S. interest rates? Explain why.

Question 56

Empirical studies suggest that, during normal times in the past two decades, covered interest rate parity applies almost perfectly to Eurocurrency markets for major currencies.

Question 57

When would a currency speculator buy a put option and when would it be worth exercising the option? What are some advantages and disadvantages of currency options compared to forward exchange contracts?

Question 58

Suppose that the U.S. dollar-pound sterling spot exchange rate equals $1.60/£, while the 360-day forward rate is $1.64/£. The yield on a one-year U.S. treasury bill is 9% and that on a one-year U.K. treasury bill is 8%. Calculate the covered interest differential in favor of London. On the basis of this result, which country would you expect to face capital inflows and which to face capital outflows?

Question 59

In a currency swap two parties agree to exchange flows of different bonds during a specified time period.

Question 60

Forward exchange contracts are used for hedging but not for speculating.